On January 1, 2011 nearly all of the Bush era tax cuts will expire. Thus taxes will automatically increase in 2011 without any action being required by congress. All of the marginal tax rates will be increased, with the highest income tax bracket going from being taxed at a marginal rate of 35% to a rate of 39.6%.
Knowing this, there are significant planning opportunities to save taxes by deferring certain deductions which could be taken in 2010 into 2011. One major deduction which can be shifted into future years is the deduction for pension contributions.
Deductions for contributions to qualified pension plans are generally allowed for the tax year in which the contributions are paid. A special rule allows an employer to treat a contribution made on or before the due date of the employer’s tax return, including extensions as being made on the last day of the tax year for which the return is being filed. For example, an employer can extend his 2010 tax return and have until September 15, 2011 to fund the pension contribution and still be able to take the deduction on the 2010 tax return.
In the case of tax year 2010, the employer will save taxes by simply filing the return before the pension contribution is made. Thus, the employer can defer the deduction into year 2011 when tax rates will be higher and therefore the benefit of the deduction will be greater.
Assume that the employer is an S Corporation with one shareholder who is in the highest income tax bracket and that the employers required pension contribution for the tax year 2010 is $100,000. If the owner were to extend the corporation’s tax return and pay in the pension contribution on or before September 15, 2011 the contribution can be deducted on the corporations 2010 return and the sole shareholder would receive a tax benefit of $35,000 ($100,000 x 35% highest marginal tax rate for 2010). If on the other hand the corporation did not extend the tax return, the pension contribution would still be due by September 15, 2011. However the corporation would take the deduction on its 2011 tax return. The sole shareholder would receive a $43,400 tax benefit ($100,000 x 43.4% the total of the 39.6% highest marginal tax rate in 2011 plus the 3.8% Medicare tax on high income individuals).
Simply by filing the corporations tax return before paying in the pension contribution the shareholder has deferred the deduction into a year in which he will have a higher tax rate and received a 8.9% greater tax benefit. It should be noted that the 2010 pension contribution will be due no later than September 15, 2011 regardless of which year the deduction is taken and this strategy will not affect the amount of your required pension contribution for 2011 or later years.
Many employers fund their pension plan contributions currently by making monthly payments or a large contribution at year end. These employers need to stop making pension contributions until after the due date of the 2010 tax return. If the tax return is filed before the due date, the due date is not deemed to have been extended for purposes of defining when the pension contribution is made.